In a Notice, IRS has provided interim guidance on Code Sec. 4960, added by the Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017), which imposes an excise tax on excess remuneration and excess parachute payments paid by an applicable tax-exempt organization to a covered employee. Until future guidance is issued, taxpayers may rely on the rules set out in Notice 2019-9.

Background. For tax years beginning after Dec. 31, 2017, Code Sec. 4960 provides that a tax-exempt organization’s covered employees who receive excess compensation or parachute payments are subject to an excise tax.

The tax is imposed at the corporate tax rate (currently 21%) on the sum of: (1) the remuneration (other than an excess parachute payment) in excess of $1 million paid to a covered employee by an applicable tax-exempt organization for a tax year; and (2) any excess parachute payment paid by the applicable tax-exempt organization to a covered employee. (Code Sec. 4960(a))

A covered employee is an employee (including any former employee) of an applicable tax-exempt organization if the employee is one of the five highest compensated employees of the organization for the tax year or was a covered employee of the organization (or a predecessor) for any preceding tax year beginning after Dec. 31, 2016. (Code Sec. 4960(c)(2))

For purposes of determining excess remuneration, wages include all remuneration for services performed by an employee for the employer, except for fees paid to a public official, and other specifically excluded types of remuneration. (Code Sec. 4960(c)(3)) Remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to such remuneration. (Code Sec. 4960(a))

An excess parachute payment is an amount equal to the excess of any parachute payment over the portion of the base amount (determined under rules similar to Code Sec. 280G(b)(3)) allocated to such payment. A parachute payment is any payment in the nature of compensation to (or for the benefit of) a covered employee if (i) such payment is contingent on such employee’s separation from employment with the employer, and (ii) the aggregate present value of the payments in the nature of compensation to (or for the benefit of) such individual which are contingent on such separation equals or exceeds an amount equal to three times the base amount. (Code Sec. 4960(c)(5))

New guidance. IRS intends to issue proposed regs on Code Sec. 4960 in the future. Until such further guidance is issued, taxpayers may rely on the rules set out in Notice 2019-9, effective from Dec. 22, 2017 (i.e., the enactment date of Code Sec. 4960).

Notice 2019-9, Q/A-2, provides that the excise tax imposed on excess remuneration and excess parachute payments is determined based on remuneration paid and excess parachute payments made in the calendar year ending with or within the tax year of the employer. Notice 2019-9, Q/A-13, and Notice 2019-9, Q/A-39, treat remuneration in which the covered employee vested before the effective date of Code Sec. 4960 as paid before that effective date.

A payment to the employee from a related entity, including a related entity that is an ATEO, for services rendered to the common-law employer, is considered a payment to the employee from the common-law employer for purposes of calculating remuneration and determining liability for the excise tax. Notice 2019-9, Q/A-3 clarifies that calculation of the excise tax is separate from any arrangement that an ATEO and any related organization may have for bearing the cost of the excise tax under Code Sec. 4960.

There can be no excess remuneration under Code Sec. 4960(a)(1) if an ATEO (together with any related organization) pays remuneration of less than $1 million to each of its employees for a tax year, and there can be no excess parachute payment under Code Sec. 4960(a)(2) if the employer does not have any “highly compensated employees” under Code Sec. 414(q) for the tax year. For example, an ATEO that doesn’t pay compensation of $125,000 or more to any employee in 2018 and 2019 is not subject to excise tax under Code Sec. 4960 for 2019. But even if an ATEO has no liability under Code Sec. 4960 for one year, the ATEO may later need to determine its five highest-compensated employees for that tax year, as those employees continue be covered employees in all future years and may be paid excess remuneration or excess parachute payments in a future year.

Covered employee. Notice 2019-9, Q/A-9, provides that once an employee is a covered employee, he or she continues to be a covered employee for all subsequent tax years. There is no minimum dollar threshold for an employee to be a covered employee; thus, an employee need not be paid excess remuneration or an excess parachute payment nor be a highly compensated employee within the meaning of Code Sec. 414(q) to be a covered employee for a tax year and all future years.

Notice 2019-9, Q/A-10, provides that whether an employee is one of an ATEO’s five highest-compensated employees is based on remuneration paid in the calendar year ending with or within the employer’s taxable year. Notice 2019-9, Q/A-10, provides that remuneration paid for medical services is not taken into account for purposes of identifying the five highest-compensated employees.

Whether an employee is one of the five highest-compensated employees is determined separately for each ATEO, and not for the entire group of related organizations; thus, each ATEO has its five highest-compensated employees. As a result, in many cases, a group of related organizations will have more than five covered employees.

Notice 2019-9, Q/A-9, provides that only an ATEO’s common law employees (including officers) can be one of an ATEO’s five highest compensated employees. Notice 2019-9, Q/A-12(c), also provides that remuneration paid by a separate organization on behalf of the ATEO, whether related to the ATEO or not, for services performed as an employee of the ATEO is treated as remuneration paid by the ATEO for purposes of Code Sec. 4960.

To prevent circumstances in which an employee to whom the ATEO paid minimal remuneration displaces an employee who would otherwise be a covered employee of the ATEO, Notice 2019-9, Q/A-10(b), provides a limited services exception under which, unless an ATEO pays at least 10% of the total remuneration paid by the ATEO and all related organizations to an employee during the calendar year, the employee is not treated as one of the ATEO’s five highest compensated employees. However, if no ATEO pays at least 10% of an employee’s total remuneration during a calendar year, this exception doesn’t apply to the ATEO that paid the most remuneration to the employee during the calendar year.

Excess remuneration. The excise tax imposed under Code Sec. 4960(a)(1) is based on the remuneration paid (other than any excess parachute payment) by an ATEO for the tax year with respect to employment of any covered employee in excess of $1 million. Notice 2019-9, Q/A-11, provides that this amount is referred to as “excess remuneration.”

Notice 2019-9, Q/A-12, clarifies that remuneration includes a parachute payment that is not an excess parachute payment, but remuneration does not include certain retirement benefits (see Code Sec. 3401(a)(12)) or certain directors’ fees.

Remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to the remuneration. Notice 2019-9, Q/A-13, provides that the definition of substantial risk of forfeiture under Prop Reg § 1.457-12(e)(1) is the definition of substantial risk of forfeiture within the meaning of Code Sec. 457(f)(3)(B) for purposes of Code Sec. 4960(a). Under Prop Reg § 1.457-12(e)(1), an amount of compensation is subject to a substantial risk of forfeiture only if entitlement to the amount is conditioned on the future performance of substantial services, or upon the occurrence of a condition that is related to a purpose of the compensation if the possibility of forfeiture is substantial.

Consistent with common usage, Notice 2019-9, Q/A-13, refers to an amount the right to which is not subject to a substantial risk of forfeiture as being “vested” and the lapsing of a substantial risk of forfeiture as “vesting.”

Notice 2019-9, Q/A-13, provides that, for purposes of determining when remuneration is treated as paid, the timing rule in Code Sec. 4960(a) applies,and the timing rule for wage inclusion under Reg § 31.3402(a)-1(b) is not relevant. Under Notice 2019-9, Q/A-13, the amount of remuneration treated as paid at vesting is the present value of the remuneration in which the covered employee vests. Notice 2019-9, Q/A-13, provides specific rules for timing of inclusion for earnings and losses on previously paid remuneration.

Notice 2019-9, Q/A-14, provides an employee may be a covered employee of more than one ATEO and that each ATEO employer calculates its liability under Code Sec. 4960(a)(1) taking into account the organizations to which it is related. However, an employer is liable only for the greater of the excise tax it would owe as an ATEO or the excise tax it would owe as a related organization with respect to that covered employee.

Notice 2019-9, Q/A-15, provides that remuneration for the direct performance of medical or veterinary services is excluded for purposes of Code Sec. 4960.

Excess parachute payments. Code Sec. 4960(c)(5)(A) provides that an “excess parachute payment” is an amount equal to the excess of any parachute payment over the portion of the base amount allocated to such payment. Notice 2019-9, Q/A-38, deals with allocating the base amount to a parachute payment (that is, determining the portion that is not a parachute payment because it does not exceed the base amount).

Separation from employment (whether voluntary or involuntary) is often used in compensation arrangements as the trigger to pay vested amounts. The guidance in Notice 2019-9 limits the payments treated as contingent on a separation from employment to payments contingent on an involuntary separation from employment because payments that vest upon a separation from employment typically vest only upon an involuntary separation from employment.

Notice 2019-9, Q/A-20, describes when a payment is contingent on an employee’s separation from employment. Notice 2019-9, Q/A-20 provides that a payment is contingent on a separation from employment if the payment would not have been made in the absence of an involuntary separation from employment. It further provides that if the right to a payment vests as a result of an involuntary separation from employment, the payment is treated as a payment that is contingent on a separation from employment.

Notice 2019-9, Q/A-20 also provides that an amount that was included in gross income in a previous year and excess remuneration that was treated as paid under Notice 2019-9, Q/A-13, before the separation from employment are not contingent on the separation from employment. Therefore, while these amounts may be included in the employee’s base amount, payments of these amounts are not parachute payments.

Notice 2019-9, Q/A-24, provides that if a payment is accelerated or a substantial risk of forfeiture lapses as a result of an involuntary separation from employment, the additional value due to the acceleration is treated as a payment contingent on a separation from employment.

Notice 2019-9, Q/A-21, provides that payments pursuant to certain window programs (i.e., a program established by the service recipient in connection with an impending separation from service to provide separation pay, for a limited period of time) are treated as payments contingent on a separation from employment and is based on Reg § 1.409A-1(b)(9).

Notice 2019-9, Q/A-23, adopts the standards of Reg § 1.409A-1(h)(1)(ii), providing that an anticipated reduction in the level of services of more than 80% is treated as a separation from employment and an anticipated reduction in the level of services of less than 50% is not treated as a separation from employment, with the treatment of an anticipated reduction between these two levels depending on the facts and circumstances.

Notice 2019-9 does not provide a presumption that a payment made pursuant to an agreement entered into or modified within twelve months of a separation from employment is a payment that is contingent on a separation from employment.

Reporting liability under Sec. 4960. Notice 2019-9, Q/A-34, provides that an employer may elect to prepay the excise tax imposed under Code Sec. 4960(a)(2) in the year of separation from employment (or any tax year prior to the year in which the parachute payment is actually paid).

Reliance. Any future guidance under Code Sec. 4960 will be prospective and will not apply to tax years beginning before the issuance of that guidance. Until further guidance is issued, to comply with the requirements of Code Sec. 4960, taxpayers may base their positions upon a good faith, reasonable interpretation of the statute, including consideration of the legislative history, if appropriate. The positions reflected in Notice 2019-9 constitute a good faith, reasonable interpretation of the statute.